MODULE 2 TOPIC 3:

ANNUITY
 ANNUITY

is defined as a series of equal payments “A” occurring at equal

intervals of time. When an annuity has a fixed time span, it is known as
annuity certain.

Instances where annuities occur:

 Payment of a debt by a series of equal payments at equal intervals of time.
 Accumulation of a certain amount by setting the amount periodically.
 Substitution of a series of equal amounts periodically in lieu of a lump
sum.
ANNUITY

Four types of Annuity

(1) ordinary annuity
(2) deferred annuity
(3) annuity due
(4) perpetuity
 1. ORDINARY ANNUITY

this type of annuity where the payments are made at the end of
each period. The equal payments are made at the end of each
compounding period starting from the first compounding period.

Cash Flow Diagram of Ordinary Annuity

 1. ORDINARY ANNUITY
Future Amount of Ordinary Annuity, (F):

𝐴𝐴 (1 + i)𝑛𝑛 −1
𝐹𝐹 = Where;
𝑖𝑖
A= Annual payment
P= Present worth or amount
Present Amount of Ordinary Annuity, (P): F= Future worth or amount
n= number of payment period
𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1 i= interest rate per period
𝑃𝑃 = 𝑛𝑛
=
(1 + i) (1 + i)𝑛𝑛 𝑖𝑖
 1. ORDINARY ANNUITY

Example 1:
What is the present worth of a 3 years annuity paying
P3,000.00 at the end of each year, with interest at 8%
compounded annually?
𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = 𝑛𝑛
=
(1 + i) (1 + i)𝑛𝑛 𝑖𝑖
Answer: P7,731.29
 1. ORDINARY ANNUITY

Example 2:
A man paid 10% down payment of P200,000 for a house and
lot and agreed to pay the 90% balance on monthly installments
for 60 months at an interest rate of 15% compounded monthly.
Compute the amount of the monthly payment.

𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = =
Answer: P42,821.87 (1 + i)𝑛𝑛 (1 + i)𝑛𝑛 𝑖𝑖
 1. ORDINARY ANNUITY

Example 3:
Maintenance cost of an equipment is P20,000 for 2 years,
P40,000 at the end of 4 years and P80,000 at the end of 8
years. Compute for the semi-annual amount that be set aside
for this equipment. Money worth 10% compounded annually.

𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = =
Answer: P7425.72 (1 + i)𝑛𝑛 (1 + i)𝑛𝑛 𝑖𝑖
 2. ANNUITY DUE

In annuity due, equal payments are made at the beginning of

each compounding period starting from the first period. The
diagram below shows the cash flow in an annuity due.

Cash Flow Diagram of Annuity Due

 2. ANNUITY DUE
Future Amount of Annuity Due, (F):

𝐴𝐴 (1 + i)𝑛𝑛 −1
𝐹𝐹 = 𝐹𝐹1 1 + i = 1+i
𝑖𝑖

Present Amount of Ordinary Due, (P):

𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = 𝑛𝑛
= 𝑛𝑛
1+i
(1 + i) (1 + i) 𝑖𝑖
Where;
A= Annual payment
P= Present worth or amount
F= Future worth or amount
F1= Future amount of Ordinary Annuity
n= number of payment period
i= interest rate per period
 2. ANNUITY DUE

Example 1:
A man wishes to have P35,000 when he retires 15
years from now. If he can expect to receive 4% annual
interest, how much he set aside in each of 15 equal annual
beginning of year deposits?
Answer: P1680.71 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝐹𝐹 = 𝐹𝐹1 1 + i = 1+i
𝑖𝑖
 2. ANNUITY DUE

Example 1:
𝐴𝐴 (1 + i)𝑛𝑛 −1
𝐹𝐹 = 𝐹𝐹1 1 + i = 1+i
𝑖𝑖

𝐴𝐴 (1+0.04)15 −1
35, 000 = 1 + 0.04
0.04

A = 1680.71
 2. ANNUITY DUE

Example 2:
On retirement, Mr. Caloy finds that her company
pension calls for payment of $750 to her or to her estate if
she dies at the beginning of each month for 25 years. Find
the present value of her pension at 8% compounded
quarterly.
𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = 𝑛𝑛
= 𝑛𝑛
1+i
(1 + i) (1 + i) 𝑖𝑖
 2. ANNUITY DUE

Example 2:

𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = 𝑛𝑛
= 𝑛𝑛
1+i
(1 + i) (1 + i) 𝑖𝑖

0.08 25(4)
750 (1+( )) −1 0.08
4
P= 25 4 1+
0.08 0.08 4
1+ ( )
4 4

P = $32, 970.24
 2. ANNUITY DUE

Example 3:
A teacher will deposit $500 with a savings and loan
association at the beginning of each 4 months for 10
years. If the association pays interest at the rate of 7%
every 4 months, find the sum of his credit just after the
𝐴𝐴 (1 + i)𝑛𝑛 −1
last deposit. 𝐹𝐹 = 𝐹𝐹1 1 + i = 1+i
𝑖𝑖
 2. ANNUITY DUE

Example 3:
𝐴𝐴 (1+i)𝑛𝑛 −1
F= 1+i
𝑖𝑖

0.07 10(3)
500 (1 + ( )) −1 0.07
3
F= 1+
0.07 3
3
F = $21, 876.46
 3. DEFERRED ANNUITY
is one where the payment of the first amount is deferred a certain number of periods
after the first.

Cash Flow Diagram of Deferred Annuity

 3. DEFERRED ANNUITY

a. Accumulation Stage. A single payment is allowed to earn

interest for a specified duration. There are no annuity payments
during this period of time, which is commonly referred to as the
period of deferral.

b. Payments Stage. The annuity takes the form of any of the four
annuity types and starts at the beginning of this stage as per the
financial contract. Note that the maturity value of the accumulation
stage is the same as the principal for the payments stage.
 3. DEFERRED ANNUITY
Future Amount of Deferred Annuity, (F):

𝐴𝐴 (1 + i)𝑛𝑛 −1
𝐹𝐹 =
𝑖𝑖
Present Amount of Deferred Annuity, (P):

𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = 𝑘𝑘+𝑛𝑛
= Where;
(1 + i) 1 + i (𝑘𝑘+𝑛𝑛) (𝑖𝑖) A= Annual payment
P= Present worth or amount
F= Future worth or amount
n= number of payment period
k= number of periods before the first
annuity
i= interest rate per period
 3. DEFERRED ANNUITY

Example 1:
A man loans P187,400 from a bank with interest at 5%
compounded annually. He agrees to pay his obligations
by paying 8 equal annual payments, the first being due at
the end of 10 yrs. Find the annual payments.
Answer: P44, 980.6
 3. DEFERRED ANNUITY
Example 1:
𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = 𝑘𝑘+𝑛𝑛
=
(1 + i) 1 + i (𝑘𝑘+𝑛𝑛) (𝑖𝑖)
𝐴𝐴 (1 + 0.05)8 −1
187,400 =
1 + 0.05 9 + 8 (0.05)

𝐴𝐴 = 44, 980.6
 3. DEFERRED ANNUITY

Example 2: A parent on the day the child is born wishes

to determine what lump sum would have to be paid into
an bearing interest at 5% compounded annually, in order
to withdraw P20,000.00 each on the child’s 18, 19th, 20th
and 21st birthdays:
Answer: 30, 941.73
 3. DEFERRED ANNUITY
Example 2:
𝐹𝐹 𝐴𝐴 (1 + i)𝑛𝑛 −1
𝑃𝑃 = 𝑘𝑘+𝑛𝑛
=
(1 + i) 1 + i (𝑘𝑘+𝑛𝑛) (𝑖𝑖)
20,000 (1 + 0.05)4 −1
𝑃𝑃 =
1 + 0.05 17 +4 (0.05)

𝑃𝑃 = 30, 941.73
 3. DEFERRED ANNUITY

Example 3:
A father wishes to provide P4,000 for his son on his
21st birthday. How much should he deposit every 6
months in a savings bank which pays 3% converted
semi-annually, if the first deposit is made when the son
is 3 1/2 year old ?
Answer: 𝟔𝟔𝟔𝟔. 𝟐𝟐𝟐𝟐
 3. DEFERRED ANNUITY

Example 3:
𝐴𝐴 (1 + i)𝑛𝑛 −1
𝐹𝐹 =
𝑖𝑖

𝐴𝐴 (1 + 0.03)36 −1
4000 =
0.03

𝐴𝐴 = 63.22
(𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎𝑎 ℎ𝑒𝑒 𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠𝑠 𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑𝑑 𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒𝑒 6 𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚𝑚)
 3. DEFERRED ANNUITY
Assignment:
1. Two years ago the rental for the use of equipment and facilities as paid 5 years in
advance, with option to renew the rent for another years by payment of P15,000
annually at the start of each year for the renewal period. Now, the lessor asks the
lessee if it could be possible to prepay the rental that will be paid annually in the
renewed 5 years period. If the lessee will consider the request, what would the fair
prepayment to be made to the lessor if interest is now figured at 8% ?
 3. DEFERRED ANNUITY
Assignment:
2. An old boiler cost P2,400 a year to maintain. What expenditures for a new
boiler is justified if no maintenance will be required for the first 3 years, P600 per
year for the next 7 years, and P2,400 a year thereafter? Assume money to cost 4%
compounded annually and no other costs to be considered.
3. A new generator has just been installed. It is expected that there will be no
maintenance charges until the end of the 6th year, when P300 will be spent at the end
of each successive year until the generator is scrapped at the end of its fourteenth year
of service. What sum of money set aside at the time of installation of the generator at
6% will take care of all maintenance expenses for the generator?
 4. PERPETUITY OR PERPETUAL ANNUITY
annuity where the payment periods extend to forever or in which the periodic
payments continue indefinitely. There is no definite future in perpetuity, thus, there
is no formula for the future amount.

Cash Flow Diagram of Perpetuity

 4. PERPETUITY OR PERPETUAL ANNUITY

For perpetuity where the periodic payments are each equal to A,

the future amount is infinite. The present value is

Present Amount of Perpetuity, (P):

𝐴𝐴 (1 + i)𝑛𝑛 −1 𝐴𝐴
𝑃𝑃 = N= infinite 𝑃𝑃 =
(1 + i)𝑛𝑛 𝑖𝑖 𝑖𝑖
Other formula of Present Amount of Perpetuity, (P): Future Amount of Perpetuity, (F):

𝐴𝐴(1 − e𝑟𝑟𝑟𝑟 ) 𝐴𝐴(e𝑟𝑟𝑟𝑟 − 1)

𝑃𝑃 = 𝐹𝐹 =
e𝑟𝑟 − 1 e𝑟𝑟 − 1
 4. PERPETUITY OR PERPETUAL ANNUITY

Example 1:
Six hundred pesos is deposited each year into a savings bank
account that pays 6% nominal interest, compounded
continuously. How much will be in the account at the end of 8
years.

Answer: 𝟓𝟓, 𝟗𝟗𝟗𝟗𝟗𝟗. 𝟕𝟕𝟕𝟕

4. PERPETUITY OR PERPETUAL ANNUITY

𝐴𝐴(e𝑟𝑟𝑟𝑟 − 1)
Example 1: 𝐹𝐹 =
e𝑟𝑟 − 1

600(e0.06(8) − 1)
𝐹𝐹 =
e0.06 − 1

𝐹𝐹 = 5, 977.77
 4. PERPETUITY OR PERPETUAL ANNUITY

Example 2: Each year a single payment of

P1766 is deposited in an account that earns 6%
compounded continuously. What is the amount in
the account immediately after the 5th payment?

Answer: 𝟗𝟗𝟗𝟗𝟗𝟗𝟗𝟗. 𝟔𝟔
4. PERPETUITY OR PERPETUAL ANNUITY

𝐴𝐴(e𝑟𝑟𝑟𝑟 − 1)
Example 2: 𝐹𝐹 =
e𝑟𝑟 − 1

1766(e0.06(5) − 1)
𝐹𝐹 =
e0.06 − 1

𝐹𝐹 = 9991.6
 4. PERPETUITY OR PERPETUAL ANNUITY

Example 3: A man borrows P100,000 at a rate of

6% compounded continuously for 5 years. How much
must he pay annually if money is compounded
continuously.
Answer: 17,674.71
4. PERPETUITY OR PERPETUAL ANNUITY

Example 3: 𝐴𝐴(1 − e𝑟𝑟𝑟𝑟 )

𝑃𝑃 =
e𝑟𝑟 − 1

0.06(5)
𝐴𝐴(1 − e )
100,000 =
e0.06 − 1

A = 17,674,71
 4. PERPETUITY OR PERPETUAL ANNUITY(ASSIGNMENT)

1. What present sum would be needed for annual end of year payments of
P15,000 each, forever if money is worth 8%.
2. What amount of money deposited 20 years ago at 4% interest would
provide a perpetual payment of P2,000 per year?
3. Find the present value of a perpetuity of P100 payable semi-annually if
money is worth 4% compounded quarterly.
4. If money is worth 8%, obtain the present value of a perpetuity of P1000
payable annually when the first payment is due at the end of 5 years.